This Notice addresses Section 1031 tax-deferred exchanges of real
property for certain tenants-in-common ("TIC") interests in real
property offerings.1 In a TIC exchange, interests in real property are
exchanged for instruments that generally are securities for purposes
of the federal securities laws and NASD rules.2 This Notice reminds
members that when offering TIC interests that are securities to
customers, members and their associated persons must comply with
all applicable NASD rules, including those addressing:

suitability;

due diligence;

splitting commissions with unregistered individuals or firms;

supervision; and

recordkeeping.

In addition, members relying on private offering exemptions from
the registration requirements of the Securities Act of 1933 must
ensure that their manner of offering TIC interests complies with
all applicable requirements, including the prohibition on general
solicitation.

Questions/Further Information

Questions concerning this Notice should be directed to Joseph E.
Price, Vice President, Corporate Financing Department, at (240)
386-4623 or Gary L. Goldsholle, Associate Vice President and
Associate General Counsel, Office of General Counsel, Regulatory
Policy and Oversight, at (202) 728-8104.

Characteristics of TIC Exchanges

Tax Status
Typically, the sale of an investment, including an investment in real estate, is a taxable
event, with the seller being responsible for capital gains taxes on the appreciation of
the investment. Under Section 1031 of the Internal Revenue Code, however, an investor
in income-producing or rental real estate may exchange the investment for another
investment in income-producing or rental real estate of equal or greater value and
defer payment of capital gains. In order to qualify for a deferral under Section 1031,
an investor must acquire an interest in real estate in the exchange, not an interest in a
partnership.

For example, if an investor purchased rental real property in 1972 for $50,000, the
property today may be worth $2 million dollars. The sale of the property would cause
the seller to incur taxes on the profit. If the owner of the rental property exchanged
the rental property for different real property, he could defer paying these taxes.
Because of the difficulty of finding equal and offsetting properties for each investor,
sponsors have offered interests in larger real estate offerings to pools of investors, in
the form of TIC interests. In the example provided, rather than exchanging a rental
property valued at $2 million for a similarly valued property, the owner could pool his
interest with other similarly situated property owners to acquire property or properties
with a large enough value to provide tax deferral for all the investors. If, however, the
pool of investors is treated as a partnership under the principles of federal tax law, the
exchange will not qualify under Section 1031, and the taxes on the investors' profits
will not be deferred under that section.

TIC exchanges have grown dramatically, from approximately $150 million in sales in
2001 to approximately $2 billion in 2004.3 The driving force behind the growth in TIC
exchanges is their favorable tax treatment.

In March 2002, the IRS issued Revenue Procedure 2002-22, 1 C.B. 733 ("Rev. Proc. 2002-
22"), which addresses the conditions under which the IRS will consider a request for a
ruling that a TIC interest in rental real estate is not an interest in a partnership. Rev.
Proc. 2002-22 describes the central characteristic of a tenancy in common (each owner is
deemed to own individually a physically undivided part of the entire parcel of property)
and sets forth 15 specific conditions that must be met before the IRS will consider
issuing a ruling.4 If the arrangement among the investors is respected as a TIC interest
in rental real estate, rather than an interest in a partnership, an exchange may qualify
under Section 1031 if the other conditions of that section are satisfied.

Securities Law Status

When TICs are offered and sold together with other arrangements, they generally
would constitute investment contracts and thus securities under the federal securities
laws.5 An investment contract includes any contract, transaction or scheme in which
persons invest their money in a common enterprise, with the expectation of profits to
be derived predominantly from the efforts of others.6 TIC interests are generally
investment contracts because the tenants in common invest in an undivided fractional
interest in the rental real property by pooling their assets and sharing in the risks and
benefits of the enterprise, while obtaining profits derived predominantly from the
efforts of others, such as through contracts concerning leasing, management and
operation of the acquired property. In addition to managing the property, TIC sponsors
typically structure the TIC and negotiate the sale price and the loan. The fact that
investors in a particular TIC program might have authority to terminate a management
contract, or even to maintain or repair the property, would not demonstrate that the
TIC interest is not an investment contract.7

Although Section 1031 does not apply to an exchange of investment property for
"interests in a partnership," "stocks, bonds, notes," or "other securities," the federal
securities law definitions of those terms do not control interpretation of the tax laws.
Accordingly, the fact that TIC interests typically are investment contracts under
securities laws does not inherently disqualify them as property that may be exchanged
under Section 1031.

We have become aware that certain states may exempt particular types of TIC
transactions from the definition of "security" under state law. We remind members,
however, that a determination that a particular transaction does not involve a security
for purposes of state law is not determinative for purposes of federal securities law.

Application of NASD Rules to TIC Exchanges

TIC interests are a type of non-conventional investment ("NCI"). In NTM 03-71, NASD
explained that members engaged in the sale of NCIs must ensure that those products
are offered and sold in a manner consistent with the member's general sales conduct
obligations, as well as address any special circumstances presented by the sale of those
products. Among the issues highlighted in NTM 03-71 are members' responsibilities to:

ensure that promotional materials used by the member are fair, accurate,
and balanced;

implement appropriate internal controls; and

provide appropriate training to registered persons involved in the sale of
these products.

Suitability and Due Diligence
Before recommending a TIC exchange, members must have a clear understanding of
the investment goals and current financial status of the investor. In many cases, a TIC
interest will constitute a significant portion of an investor's total assets. Because of the
favorable tax treatment, investors often elect to invest the entire proceeds from the
sale of an investment property in a TIC exchange. Concentration of an investor's assets
in a single asset class, however, is not suitable for many investors.8 Members must, with
respect to each customer for whom they make a recommendation, consider the risks
from over-concentration against the benefits of tax deferral and the investment
potential of the underlying real estate asset(s).

TIC interests are illiquid securities. NASD is not aware of any secondary market for TIC
interests. Moreover, the tenant-in-common form of ownership may require unanimous
consent to sell a TIC interest. The subsequent sale of TIC interests may only be possible
at a significant discount to the net asset value of the undivided interest in the real
estate. As fees charged in connection with a TIC exchange increase, the money saved as
a consequence of tax deferral will be offset. Accordingly, members should consider the
effect of fees on each TIC exchange.

TIC exchange sponsors routinely obtain legal opinions regarding whether a particular
TIC's offering structure will qualify as a like-kind exchange of real property under
Section 1031. Given the importance of that tax treatment, a member should obtain a
"clean" legal opinion that a TIC "should" or "will" qualify for exchange under Section
1031. If a sponsor failed to obtain a legal opinion, or only obtained a "more likely than
not" opinion, that would be a material fact. In such a case, a member, as part of its due
diligence responsibilities would be required to ascertain the specific tax status risks of
the TIC exchange and inform the investor of the risks involved.

In making a suitability determination in connection with a recommendation to a
customer to purchase a TIC interest, a member must also consider whether the fees and
expenses associated with TIC transactions outweigh the potential tax benefits to the
customer. TICs structured with high up-front fees and expenses paid to the sponsor
and/or salespersons of the selling broker-dealers raise particular concerns about the
ability to make a suitable recommendation. In addition, TIC transactions in many cases
may not provide complete tax-free exchanges for investors (e.g., in situations where the
investor's debt ratio on the replacement property decreases, the difference may result
in a taxable event for the investor). Members must take all of these factors into
consideration when recommending a particular TIC transaction to a customer.

NTM 03-71 reminds members that the type of due diligence that is appropriate will vary
from product to product. NASD staff believes that it is not appropriate for members
that recommend a TIC transaction simply to rely on representations made by the
sponsor in an offering document. While the nature and extent of verification will
vary with the facts and circumstances related to particular sponsors and offerings,
members should make a reasonable investigation to ensure that the offering document
does not contain false or misleading information. Such an investigation could include
background checks of the sponsor's principals, review of the agreements (e.g., property
management, purchase and sale, lease and loan agreements) and property inspection.9
In addition, if the offering document contains projections, members should understand
the basis for those projections, and the degree of likelihood that they will occur. For
example, members should determine whether any projected yields can reasonably be
supported by the property operations.

Payment of Referral Fees
Real estate agents sometimes refer their customers to broker-dealers that offer TIC
exchanges. Moreover, some states may require that a licensed real estate agent
participate in the transfer of a TIC interest to an investor. A broker-dealer that pays a
fee to the real estate agent or splits its brokerage commissions with the agent in
connection with a TIC exchange may be deemed to have violated NASD Rule 2420. This
rule generally prohibits the payment of commissions and fees to entities that operate
(or based on the proposed activities, would operate) as unregistered broker-dealers.
Under Section 3(a)(4)(A) of the Securities Exchange Act of 1934, a "broker" is defined as
a person "engaged in the business of effecting transactions in securities for the account
of others." Section 15(a) of the Exchange Act sets forth the general registration
requirements for brokers and dealers.10

The determination of whether an entity should be registered as a broker-dealer rests
with the Securities and Exchange Commission. Among the activities the SEC staff has
found require registration are:

receiving transaction-based compensation;

participating in presentations or negotiations;

making securities recommendations or discussing or presenting the
attributes of a securities investment;

structuring securities transactions; and

recommending lawyers, underwriters, or broker-dealers for the distribution
or marketing of securities in the secondary market.11

It is our understanding that the SEC staff would deem a real estate agent's receipt of a
referral fee from a broker-dealer in connection with the sale of a TIC interest to be the
type of activity that would render the real estate agent an unregistered broker-dealer.
Therefore, under Rule 2420, a member may not pay a real estate agent who is not
registered as a broker-dealer for participating in the transfer of a TIC interest that is
structured as a security, nor may a member pay such real estate agent for referring TIC
business that involves securities.12 A member also may not evade Rule 2420 through
indirect payments; for example, a member may not engage in an arrangement in which
it reduces its normal commission for a TIC exchange so that the customer will pay the
difference to the real estate agent for participating in the TIC exchange or for referring
business to the broker-dealer.

Members that act as TIC sponsors and pay fees to real estate agents should carefully
review SEC and NASD precedent and, if necessary, consult an attorney with experience
in these matters.

Licensing, Supervision and Recordkeeping
Associated persons selling TIC interests must have passed the appropriate qualification
examinations. Because TICs are typically structured as direct participation programs
("DPPs"), associated persons who sell them generally must have passed either the Series
7 or the Series 22 (Limited Representative — Direct Participation Program securities).
In addition, most states require the Series 63 State Agent's license. Also, as with any
security, a TIC interest transaction must be reviewed and endorsed by a qualified
principal in accordance with the member's supervisory procedures.13 A qualified
principal for supervising TIC interests would be either a General Securities Principal
(Series 24) or a DPP principal (Series 39).

In accordance with NASD Rule 3010, members should establish an appropriate
supervisory system for the offer and sale of TIC interests. The system should include
comprehensive written supervisory procedures reasonably designed to ensure
compliance with all applicable rules, including suitability and sales practice
requirements related to TIC transactions. The supervisory system should address the
sales practice issues discussed in this Notice, including ensuring that neither the member
nor its registered representatives pay referral fees or otherwise share transaction-based
compensation from TIC transactions with persons that would be deemed to be
unregistered broker-dealers.

NASD and SEC record keeping and retention requirements also apply to TIC
transactions, and firms should establish appropriate procedures to comply with the
applicable requirements in SEC Rules 17a-3 and 17a-4, and NASD Rule 3110. Due to the
complexity and varying documentation requirements of TIC exchanges, firms should
examine the records they maintain and ensure that applicable record keeping
requirements are satisfied.

Private Offering Exemption
Many TIC transactions are conducted without registration under the Securities Act of
1933 as private placements, most in reliance on Regulation D under that statute.14 One
of the fundamental requirements of most Regulation D offerings is a prohibition on
general solicitation.15 As a result of this prohibition, neither the issuer nor any person
acting on its behalf may offer or sell securities based on general solicitation or general
advertising, including communications published in any newspaper or similar media or
any seminar or meeting whose attendees have been invited by any general solicitation
or advertising.

A critical factor in determining whether a communication is appropriately limited, and
thus not a "general solicitation," is the existence of an adequate pre-existing
relationship between a member and the TIC offeree. An adequate pre-existing
relationship will enable the member to evaluate the potential TIC investor's
sophistication and financial circumstances.16

If a communication is made by general solicitation, then an issuer or its agents will have
made a prohibited general solicitation if the communication includes an offer of the
privately placed securities. If the communication references a security that is currently
offered or contemplated to be offered at the time of the communication, the
communication will generally be considered an offer of that security. In addition, if the
person solicited via the communication is subsequently offered a security that was
currently offered or contemplated to be offered at the time of the communication, the
communication would generally be considered an offer of that security.

Members have requested guidance with regard to two specific methods of solicitation
or advertising. In the first scenario, a registered representative who also holds a real
estate license solicits potential investors by advertising a "real estate" seminar. At the
seminar, investors are given a presentation on TIC exchanges and are made aware that
the member offers TIC investments to its customers. Since the advertisement for the
seminar would be a general solicitation, and since the references to the TIC investments
currently being offered by members would be deemed an offer of those securities, the
members engaged in such offerings would not be able to rely on the exemption from
registration for private placements under Regulation D.17

In the second scenario, members place advertisements in newspapers and magazines
that indicate that the member sells TIC interests, but the advertisements do not identify
any particular TIC investment for sale by the member. Since the advertisement itself is a
general solicitation, the issue for members is whether the advertisement includes an
offer of securities. In general, such an advertisement would not be deemed an offer of
securities if:

the advertisement is generic;

the advertisement is not being made in contemplation of an offering; and

the member has procedures to ensure that an investor solicited via the
advertisement will not be offered TICs that the member is currently offering
or contemplating offering at the time of the initial contact.

Advertisements that do not meet each of these conditions are likely to be deemed
general solicitations and inconsistent with the conditions for private placements
conducted in compliance with Regulation D. Moreover, in addition to meeting these
conditions, the other requirements under Regulation D also must be met, including
establishing an adequate, substantive and pre-existing relationship with the investor
and completing a suitability analysis prior to offering TICs to an investor.18

1 This NTM is focused on investors exchanging real
estate for TIC interests. NASD is aware that some
investors purchase TIC interests directly, without a
corresponding exchange of real estate. Many of
the concepts discussed herein are applicable to
investors in TIC interests who are not exchanging
real property.

2See, e.g., SEC v. Edwards, 540 U.S. 389 (2004), 124
S. Ct. 892 (2004). See also Triple Net Leasing, LLC,
SEC No-Action Letter, SEC No-Act. LEXIS 824 (Aug.
23, 2000). (The staff of the SEC's Division of
Corporation Finance stated that it was unable to
assure the requestor that it would not
recommend enforcement action to the
Commission unless the described TIC exchanges
subject to a master lease agreement were
registered under the Securities Act of 1933 or
exempt from such registration.)

3 Terry Fiedler, Buying a Little Piece of a Big Deal,
Minneapolis Star Tribune, August 16, 2004; Terry
Pristin, Money Flowing New Way to Pool Buyers,
New York Times, September 22, 2004.

4 The 15 factors are: Tenancy in Common
Ownership; Number of Co-Owners; No Treatment
of Co-Ownership as an Entity; Co-Ownership
Agreement; Voting; Restrictions on Alienation;
Sharing Proceeds and Liabilities upon Sale of
Property; Proportionate Sharing of Profits and
Losses; Proportionate Sharing of Debt; Options;
No Business Activities; Management and
Brokerage Agreements; Leasing Agreements;
Loan Agreements; and Payments to Sponsor.
Detailed information concerning these conditions
is provided in Rev. Proc. 2002-22.

5 TIC interests in real property standing alone
generally are not securities, but are a form of
ownership in which each tenant (i.e., owner)
holds a fractional undivided interest in real
property under state real property law.

7 Rev. Proc. 2002-22 limits the activities of TIC
interest holders to those "customarily performed
in connection with the maintenance and repair of
rental property." Rev. Proc. 2002-22, at 18 (2002).
IRB LEXIS 122 *8.

8See Stephen Thorlief Rangen, 52 S.E.C. 1304, 1308
(1997) (finding that broker's recommendations
were unsuitable where they resulted in 80
percent of the equity in customers' accounts
being concentrated in one stock – "by
concentrating so much of their equity in
particular securities, [the broker] increased the
risk of loss for these individuals beyond what is
consistent with the objective of safe, nonspeculative
investing"). See also Stephen Thorlief
Rangen, 53 S.E.C. 290, 292 (1997) (Order Denying
Motion for Reconsideration) ("[O]ur findings of
undue concentration served to support our
conclusion that Rangen's recommendations were
unsuitable."); Department of Enforcement v.
Daniel R. Howard, No. C11970032, 2000 NASD
Discip. LEXIS 16, at *19 (Nov. 16, 2000) (holding
that the broker's recommendations "also led to
an undue concentration of these speculative
securities, making the recommendations
particularly unsuitable"), aff'd, Exchange Act Rel.
No. 46269, 2002 SEC LEXIS 1909 (July 26, 2002),
aff'd, No. 02-1939, 2003 U.S. App. LEXIS 19454
(1st Cir. Sept. 19, 2003); Dane S. Faber, Exchange
Act Rel. No. 49216, 2004 SEC LEXIS 277, at *26
(Feb. 10, 2004) ("We have repeatedly found that
high concentration of investments in one or a
limited number of speculative securities is not
suitable for investors seeking limited risk.").

9 For example, members should make a reasonable
investigation to ensure that any agreement
associated with the TIC transaction, such as a
master lease agreement with a real estate
investment trust or its operating partnership,
does not mandate a transaction subsequent to
the acquisition of the TIC interest that would
threaten the tax treatment of the acquisition
under Section 1031.

12 A member that pays fees to an unregistered
person who acts as a finder would not be
deemed to violate Rule 2420 if the member
obtained a no-action letter from the SEC staff
indicating that the finder is not required to
register as a broker-dealer.

13 Rule 3010(d).

14 17 CFR 230.501–508.

15 Rule 504 under Regulation D has certain
exceptions from the general solicitation
limitations.

16 E.F. Hutton & Co. Inc., SEC No-Action Letter,
1985 SEC No-Act. LEXIS 2917 (Dec. 3, 1985) (In
determining what constitutes general solicitation,
the Division of Corporation Finance underscored
the importance of substantive, pre-existing
relationships with offerees prior to their being
solicited); Bateman Eichler, Hill Richards, Inc., SEC
No-Action Letter, 1985 SEC No-Act. LEXIS 2918
(Dec. 3, 1985) (Division concurs in the view that it
would not constitute a general solicitation if
proposed solicitation that would be generic in
nature, would not make any reference to any
specific investment currently offered or
contemplated to be offered at the time of the
solicitation, and persons solicited are not offered
any securities that were offered or contemplated
for offering at the time of the solicitation); see
also H.B. Shaine & Co., Inc., SEC No-Action Letter,
1987 SEC No-Act. LEXIS 2004 (May 1, 1987);
Woodtrails-Seattle, Ltd., SEC No-Action Letter,
1982 SEC No-Act. LEXIS 2662 (Aug. 9, 1982).